Ijarah financing

The acquisition of assets is a major commitment for many businesses. Asset acquisition financing makes it possible for business owners to acquire the asset without needing to invest the total cost in a lump sum payment and thus provides greater flexibility in terms of financing to meet individual business requirements. Leasing is a form of asset finance that permits a business to use an asset or property owned by another party. It offers a mechanism that allows the separation between ownership and use. Leasing an asset corresponds to a purchase of the use of the asset over a fixed period of time. Lease can be simple rental or more elaborate contractual arrangements committing the parties to future action. The quantum of the lease payment at agreed intervals can be re-negotiated between the bank and the client.
In Islamic finance, Ijarah is an increasingly popular Shari’ah-compliant financial structure in all forms of asset financing. It is a mode of finance where the Islamic bank purchases an asset or equipment at the request of a client and leases it to the client a price that includes a fair return for the bank. Ijarah is generally used by Islamic banks for financing consumer goods, equipment and vehicles, home financing; it has also found its way into project and transportation financing and into asset-based financing in larger and more complex transactions. Under the standard Ijarah contract, the client does not normally have the option to purchase the leased asset in installments; he may however purchase the asset at the end of the lease period. This may be achieved by means of Ijarah wa Iqtina, that is equivalent to a leasing and installment loan in conventional banks, whereby each lease rental payment includes a portion of the agreed asset price and can be made for a term covering the asset's expected life. The optional purchase price declines over the period of the lease agreement.
When the client of an Islamic bank decides to lease an asset under Ijarah, he pays lease rentals to the bank in return for the right to use the asset for a specified period. At the end of the lease period the asset may be sold to the business at nominal value. The client advises the bank details of the asset required to be purchased by the bank and enters into an understanding covering overall structure of the lease contract with the bank as lessor and the client as lessee, The decision to provide Ijarah financing is based on the financial position of the client and the expected cash flow from the leased asset, in the same manner as is done by the conventional banks, but without involving interest. The bank can directly purchase the asset or appoint an agent for the purpose. If the asset is to be imported, the bank can appoint the client its agent to place the order with the foreign supplier on behalf of the bank. The lease can be made operative from the date the lessee takes delivery of the asset, the rental payments start accruing from that time. If the client delays in using the asset due to any problem attributable to the lessee, then the lessee will have to pay the rentals from the date of delivery. In case of early termination of the lease the bank would take the asset back or the lessee could purchase the asset as per the terms of the agreement.Lease rental payments differ from financing interest charged by conventional banks where all risks are borne by the lessee, while in Islamic lease the risk of the asset will be that of the bank as long as the client serves as its agent for purchase of the asset. Islamic banks also use regular re-pricing of the lease to ensure that returns are competitive within the prevailing market; in fact, lease securitisation is viewed as one of the more likely methods of developing the secondary market.